The financial planning revolution: Kohler

That the Australian Securities and Investments Commission has fully embraced everything I have been saying about financial advice is both amazing and gratifying.

In its submission to the Parliamentary inquiry into financial services released yesterday, ASIC has recommended a ban on financial planning commissions and the introduction of a legislative fiduciary duty on planners.

It has even come out against remuneration that is a percentage of funds under advice, rather than an hourly rate, saying that it “also encourages sales and borrowing”.

“Disclosure appears to be an ineffective tool to overcome conflicts of interest.”

This is such a fantastic development, and such a dramatic shift in the debate around financial advice, that I won’t even mention how long it has taken ASIC to see the light.

Er…on second thoughts, yes I will. I began pointing out the problems with financial planners being paid commissions in 2003 in the Fairfax newspapers and setting out flaws in the Financial Services Reform Act soon after it was introduced in 2004.

My speech to the 2006 ASIC Summer School in Double Bay in Sydney in March of that year was energised by the collapse of Westpoint the month before.

Between sessions at that conference I was talking on the phone to a distressed 30-year-old mother of four named Maha, pregnant with her fifth child, who had been persuaded by a financial planner on 10 per cent upfront commission to mortgage her and her husband’s house in Wentworthville and invest in Westpoint. They were about to lose the house, their only asset.

In that speech I laid out what was wrong with the FSR Act: that too much disclosure equals no disclosure at all for ordinary people unable to understand it, and that it was ASIC’s job in my view to actually protect people like Maha by banning commissions – not just to make sure they were given a massive PDS that they wouldn’t read.

The next time I was invited to an ASIC Summer School was 2008 in Melbourne, when the theme was: “The limits of disclosure”. Peter Kell from the Australian Consumer Association (now a deputy chair at the ACCC) and I used the occasion to attack the conflicts of interest that riddle financial advice and to propose legislation banning commissions and a fiduciary duty on planners.

Throughout this period I was pretty much a lone media voice attacking commissions, percentage-based fees and the sales culture that dominates the provision of financial advice in Australia. Needless to say financial planners and their masters at AMP, AXA and the banks were not pleased, accusing me of indiscriminately slandering many good advisers.

In 2005, I launched Eureka Report as an independent alternative to conflicted investment advice with the support of investment bankers John Wylie and Mark Carnegie.

But I never thought I would read words like these in an official document: “ASIC believes that the current structure of the advice industry reflects a sales culture resulting in conflicts of interest that may be inconsistent with the provision of quality advice.”

The shift in official thinking on this subject, including Minister Chris Bowen raising the possibility of a legislative ban on commissions a couple of weeks ago, surely now heralds a legislative revolution in how financial advice is provided and paid for.

If that ban were extended to percentage fees based on funds under advice, as suggested by ASIC, it would be the most dramatic and extensive revolution imaginable.

Yesterday the Financial Planning Association reacted with horror to that last idea.

In its response to the ASIC submissions the FPA’s Jo-Anne Bloch said: “If an hourly based fee is the only payment allowed, middle Australia will suffer the most … if you are just starting out on your financial journey, forking out $3000 for a strategic review that would position your finances for the next 20 years may simply be out of reach, never mind the review process that is needed to keep you on track.

“Using hourly based fees alone present a potentially detrimental step economically that would end up in significant job losses, enormous restructuring, and even further loss of confidence in financial advice.”

As I have written many times, there are three problems with percentage fees, even though they might seem a good thing:

• Most people don’t understand percentages or the principle of compounding;
• The fee grows at the same rate as contributions plus investment return, which is typically much greater than wage inflation and rent, and thus the adviser’s costs;
• The fees go on and on, bearing no relationship to the service actually provided in a particular year.

Which is why, of course, financial planning firms command a multiple of three-to-four times revenue when they are sold, as opposed to the usual multiple of one times annual revenue for the sale of accounting firms that simply charge an hourly rate.

That’s why accountants have been so keen to move into financial advice, instead of just doing tax returns – so they can build the value of their businesses and therefore their own retirement sums when they sell. And it’s why the FPA is so desperate to defend against hourly rates.

Unlike accountants and lawyers, even the independent financial planners charging a percentage-based fee for service don’t have to front their clients each year and justify the fees, and ask for an increase to keep up with inflation. The fee just goes up automatically at about three or four times the CPI, year after year.

Banning all commissions and percentage-based fees would destroy a colossal amount of goodwill in the financial planning industry and consign planners to the retirement lifestyles of accountants, god forbid.

It would also mean a lot of people couldn’t afford, or wouldn’t want to pay for, financial advice if they had to write a cheque for it, as opposed to simply letting the adviser quietly deduct 1% out of their account every year.

But as I have also written many times before, since much of the “advice” is actually just a sales job, that’s perhaps no bad thing. Decent financial advice has a value; if it seems to cost nothing, that’s probably what it’s worth.

But in any case, here’s a compromise solution: charge a fixed price for a financial plan, plus an hourly rate for follow up advice, and then deduct that amount from the client’s account balance over time – not as a percentage of funds under advice, but as a fixed amount.

Advisers might even find they get more clients because they are trusted more. As ASIC points out in its submission, as few as 22% of the adult population is getting advice. Why would that be?

This article first appeared on Business Spectator.